009: MO' MONEY MO' PROBLEMS - IS MONEY THE ROOT OF ALL EVIL?
“B-I-G P-O-P-P-A, no info. for the D-E-A
Federal agents mad coz I’m flagrant
Tap my cell and the phone in the basement.”
If you are in a state of confusion as to why this post starts with those lyrics, then I am highly disappointed in you.
Anyway sha , what is money?!
We are completely obsessed with money, but do we actually know what it is? Not what we think money is, but what money actually is? I put this question to my followers on Twitter (@DISUNOMICS), and the vast majority described it as a means of exchange, a tool for survival, a reflection of purchasing power, having options on how you live your life, etc. I can see you guys nodding your curly high tops in agreement; all of those statements make sense. And, still:
What is money?
Money is actually debt.
If we enter Bulma’s time machine - before we had iPhones recording those weirdos pestering their 98 year-old grandmothers to start dabbing - money was, essentially, a token of debt. From as far back as 3000BC, clay tablets were used to record what was owed, and were then kept in temple vaults. I will illustrate further with an example. Say there was a farmer who harvested corn, and a maker of luxury clothing, how would they commence in exchange? The farmer may need the clothes presently, but will have nothing to trade until the corn is ready for harvesting! Therefore, to prevent a halt in proceedings, the clothes-maker can agree to trade the clothes for a debt token promising that, by a certain date, they will receive X amount of corn. That debt token is essentially money! The clothes-maker can now use that debt token to exchange for meat, if they so wish.
This is exactly how our beautiful pound notes and coins exchange hands today. There were external authorities, such as kings, that gave authorisation to these debt tokens (money), and the tokens needed to be stored somewhere and cleared. This is where banks come in; they are basically like the Big Yellow Storage for our racks (on racks on racks). Banks reduce the need for these debt tokens to continually exchange hands.
If we look at the notes in our pocket (if you don’t have any, worry not, God is in control) they state: “I promise to pay the bearer on demand the sum of X pounds”. Basically, that promise is you saying that you will pay your debt! So: money=debt, debt=money. Brazy.
If money is debt, how does it work?
Banks essentially CREATE NEW MONEY, which they then lend to their customers. Essentially, banks lend money into existence. Yes, Natwest are really out here in these streets doing Houdini. Let me explain how the magic happens.
Okay, I walk into Barclays tomorrow and ask them for a cheeky £90,000 loan, so I can stunt in a G-Wagon. I need everybody on my Snapchat (trash app) and Instagram to know that I am a big baller, shot caller, baller. Miss Ayesha Diaz at Barclays is not going to need her broomstick today; it won’t be necessary for her to hit the streets to find £90,000 to finance this loan. She will simply press a few buttons on her vintage PC (why are their PCs so ugly and slow, when they have so much money, by the way?) and conjure £90,000 out of thin air, which she will then abracadabra into my account, all the while murmuring incantations (technical jargon) to hypnotise me into agreeing to pay Barclays back at a rate of, say, 10% APR (basically, an extra 9k for their troubles – charms are no small feat, just ask Nigerian women). I then exit the bank and use that money in my account to go to the Mercedes show room and make it rain. I now have in my possession the new G-Wagon, with all of the features that I will brag about but never use. Skrr Skrr. £90,000 has transferred from my Barclays account to Mercedes’ Natwest account. They can now use this money to help create more cars, which leads to more jobs, which leads to more people having more money to buy stuff in the economy. As the great people of Nigeria like to say: “Everything na double, double”. In economics, we call this the multiplier effect. The debt I have with the bank sits on their balance sheet long term (we will review this later). Funnily enough, debt is what drives economic growth. Naturally, we are raised to be scared of debt, but the reality is that we cannot really avoid it. Furthermore, when harnessed correctly, debt leads to growth. If we all ran a million miles away from debt, our good friends the luxury clothes maker and the corn famer would not have proceeded with their transaction.
Debt makes economic growth possible. When people take out loans to do business, they can make profits and create jobs that then lead to income. The level of debt equals the potential income generated. This is good for the economy because it means that we are getting richer. Yay!
Why we are in trouble
Life is not as neat as the mini-scenarios I set out. Our debt burden is incredibly high. In plain English: our debt is considerably larger than our income. This is a problem for governments, businesses and households. In early November 2016, The Money Charity report suggested that UK Household debt had risen to £1.5trillion. The average UK adult has approximately £30,000 debt, with about 10% of that debt being attributed to credit cards and loans. If you look at countries such as Australia, Switzerland and Denmark, their debt is higher than their income. Very very bad!
The reason why this is such a big problem is that the majority of this debt is not like the helpful debt we have been discussing prior, the debt that creates income and enables people to get new jobs off your bootcut FUBU jeans expenditure. A big chunk of the debt in our economies is attributed to property and financial assets. A financial asset is not something we can necessarily see or touch (well, most of us). They are a bunch of claims with contractual agreements saying if X goes up by Y in 10 years you get £X. If it sounds a bit complicated, it’s because it is. Property and financial assets do not tend to lead to income as much, rather they create wealth. In principle, the person who owns the asset gets richer if the price of it rises, and they will benefit from that income if they choose to sell it.
I will illustrate the point. Say, I go to get a loan for a house, instead of getting a loan to do YMCMB. The banker creates the new money, and I use that to purchase a home. If I choose to live there, I am paying mortgage repayments every month at the rate agreed upon. Money is not going back into the economy directly. There are no new cars being made, and no new jobs created. If anything, I am spending less money on goods and services in the economy because I have to use more of my money to pay back this debt! So, the amount of debt in the economy has gone up, but not the level of income. Most bank credit is used to invest in existing financial assets, instead of loans that help the economy. Why? Surely this is potentially harmful, so why do banks continue to do it? The answer is simple: incentive. The banks are likely to make more money from these assets, than from the interest people like us pay back on loans to build businesses. So, money, which is debt, is actually quite a bad thing right now.
The real banter of the matter is that, if we look at the net worth of the UK, taking into account all assets, according to the Office of National Statistics, in 2013 the UK has a net worth of £7.6trillion. That is £120,000 per person. Yeah flipping right! Although increasing value of assets increase wealth, it does not increase income. Simultaneously, debt is increasing, as is the burden. Bad news guys L . This financial asset and property part of our system is not really in macroeconomic theory. It does not follow the laws of equilibrium, demand and supply (which I explained in the last post www.disunonomics.com/blog/008). If you remember, we talked about how the higher the demand there is for something, the higher the price will be? If the price drops, the demand increases. That is the REAL economy’s way of balancing things. This theory cannot be applied to property and financial assets. What happens if the price of property or a financial asset rises? More and more people flock to purchase it! The demand INCREASES instead of decreasing, like it would for goods in the real economy.
"I don't know what they want from me, It's like the more money we come we across, the more problems we see" - Kelly Price
This is because the incentive to gain MORE wealth drives people to purchase. They be on that Warren Buffet vibe. If, however, the price of property or a financial asset starts to fall, people start panicking to ship their assets. This is how the world tends to end - LOL. This is what those old geezers in suits on the news mean when they talk about housing bubbles bursting.
Another problem (which personally I’m not too fussed about, but many seem to be) is wealth inequality. When asset prices rise quickly, banks have more incentive to invest in those assets than lend me money to build a luxurious durag business. They get better returns investing in those assets, than the interest they gain from my loan. This is bad news because the rich people, who already own assets, are getting richer (because those assets are now worth more than before), and the middle- and lower-class people have much smaller gains because they have to borrow to get on the asset party boat.
Banks and their asset affection are not all bad for the economy, they do help! For example, for every £11 the UK government receipts, £1 of it comes from the financial industry. I think it is fair to say the loans that lead to the production of an income are probably more valuable and less dangerous to the economy and us, the normal people. Just look at what happened 8 years ago, the financial crash in 2008 sent the world into a frenzy. Life has been significantly tougher for many people in the western world since that almighty mess. The mortgage market in the USA just fell down and died. People could not afford to pay their mortgages, and the banks were swapping mortgage debt contracts like Pokémon cards. Nobody knew who owned which debt. House prices started to fall, leaving people in more debt than their houses were even worth.
Banks that were part of this mess started reducing their lending because they are scared; they do not believe that people have the money to repay the loans. People are defaulting on loans left, right and centre. This is even worse for the real economy because businesses that need loans to invest and run their business cannot obtain one. We the consumers now have less money because we are repaying more debt. WOES! This is why you probably have heard the term “credit crunch” – it is because there was not enough credit to go around. Nobody was trying to take more Ls. (Ls they created and downloaded themselves, the cheek).
The scariest thing is that this is a systematic flaw. This will CONTINUE to happen. History repeats itself:
· The great depression – 1920.
· Wall Street crash, Great depression in 1929
· Global recession in 1980
· Black Monday Stock Market Crash in 1987
· Dot Com Bubble in 2000
· Mortgage Derivatives Crash 2008
These things may look like jargon to you, but they are a list of deadly days (well, years) we have faced due to this flaw in our system. This needs addressing asap, because we the regular people tend to face the brunt of the woes.
How do you mend a broken heart?
The system is flawed. This is not part of macroeconomics. Our decision-makers need to wake up, take a long look in the mirror and smell the coffee; we are facing very tough times. The financial sector has been doing BMF for two decades, and it may take longer than that to get over the damage done. There are so many BAD debts in our economy, and most are likely to be written off, as they are impossible to pay off.
A lot of people like to scream at bankers: “STOP THEIR BONUSES. CAP THEM!” Sorry guys, but this is not going to do anything. What needs to be done is the financial sector needs to get a haircut and go on a diet. He is too hench (colloquialism for being violently muscular in shape. The economy does not need inflated asset markets; it is not providing income, and it is causing inevitable doom. One way or another, we need to get banks giving out more productive loans, than these dodgy “assets” that nobody seems to want when the market goes *** up! The bad loans just need to go.
There is, however, a problem. A lot of our savings and pensions are invested in these assets. Therefore, if these debts are to be wiped, so will our pensions. Also, if these banks do not get their money back, they will be more reluctant to produce the loans that the real economy needs. We just need to face the punishment because it is unavoidable.
The bad side of banks needs to be isolated. Maybe the government can create an entity that scoops up these rubbish assets-inflating banks’ balance sheets, and hope and pray that one day they increase in price and sell them for profit. Another possibility is that we pressure the government into taxing these sides heavily. If you are going to not contribute to income, and cause long-term pain, you can at least pay the price. There needs to be a way we can incentivise banks to invest into the real economy!
Unfortunately for us, politicians are too scared of the banks because they pay for their campaigns to get re-elected. You cannot bite the hand that feeds you because nobody is trying to starve. It is up to the people to leave the Kardashians or Mesut Ozil for a few hours, and lobby the people we elect into doing what is in OUR best interest, not what is good for their career. Money, which is something we all love and chase, is in fact being manipulated in a way that harms us long-term. Mo' money, Mo' problems